People who do not pay their water bills should have their supply restricted, an influential Lords committee has said.
Ministers says a growing population puts pressure on supplies
The science and technology committee says 15% of people currently do not pay their bills, safe in the knowledge they will not have their supply cut off.
The peers' report also calls for water meters and more action to cut leaks.
They say UK water policy is generally "a muddle" with the failure to consider water supply implications of policies such as huge housebuilding programmes.
In particular they say John Prescott's old department failed to allow for water scarcity when planning new homes.
Committee chairman Lord Selborne said the committee, investigating water management, had been "shocked" at the numbers of people who do not pay their water bills, which lead to water firms writing off £960m a year.
He said many people "know they can't be cut off, so there's no reason to pay their bill... it means that every one of us pays an extra £10 to cover their bill".
The report calls for action against those people who can afford to pay their water bills, but refuse to do so.
Lord Selborne explained that a device was in use in Australia which allowed enough water to satisfy the basic health and safety requirements but nothing more.
The peers' say they were concerned that the water watchdog Ofwat had not taken the problem of shortages seriously enough.
"Our key message is that the government must work much harder to integrate environmental, social and economic interests in the management of water," their report said.
The committee wants a major cut in high leak levels from water company pipes.
Lord Selborne said his committee was given incorrect information by the government about what the increased water demand might be in areas of housing development such as the Thames Gateway.
He said former Environment Minister Elliot Morley wrongly told the committee increased water consumption would be just 0.1%.
That was a charge denied on Tuesday by Housing and Planning Minister Yvette Cooper who said there was a misunderstanding about what Mr Morley had told the peers.
Lord Selborne said there was a lot of consultation going on now about the issue, but he said the committee would have liked to see it happening earlier.
"It takes a long time to plan new infrastructure," he told the BBC.
"If you're going to put 200,000 houses into an area, you've got to start planning the reservoirs, the pipes, the cleaning plants for the water, everything like that at least 10, probably 15 years ahead, and of course in this country we're not good at long-term planning.
"I'm afraid the government doesn't think that far ahead."
He added that the issue of water shortages required everyone to pull together - and that included people not moaning when roads were dug up to repair leaking water pipes.
In their report, peers urged the government to make it easier for water companies to have universal metering of customers and at the same time provide help through the benefits system for people struggling to pay their bills.
Conservative environment spokesman Peter Ainsworth said: "Everyone, except Mr Prescott, is aware that the South East is suffering from water shortages.
"It is deeply irresponsible to build houses unless water efficiency comes as standard, it is as simple as that."
'More homes needed'
Ms Cooper said the growing and ageing population meant a rising demand for water and for new homes.
"We need more homes to help first time buyers and cut overcrowding but good planning means we can improve water efficiency at the same time," she said.
Meanwhile a spokesman for the Home Builders Federation said: "It is crucial to recognise that houses do not use water - people do - and it is the people who are living and working in the South East now who need homes."
He acknowledged that measures were needed to better manage water supply but insisted new homes were "part of the solution, not the problem".
Tom Le Quesne of environmental group WWF said public water supply was on a "knife-edge", particularly in the South East.
"We can resolve the problem; there's a whole range of measures we can take," he told BBC Five Live.
"First and most important is that any new-build housing should be built to the highest standard of water efficiency."